McGraw Hill’s Taxation of Individuals 2022 Edition 13th Edition by Brian Spilker Solution manual

Melinda earns $12,000 of interest on the City of Heflin bond (i.e., 6% × $200,000).  A similar priced taxable bond (i.e., the Surething Inc. bond) would pay $16,000 of taxable interest (i.e., 8% × $200,000).  Melinda pays $4,000 of implicit tax on the City of Heflin bond (i.e., the difference between the pretax interest earned from a similar taxable bond ($16,000) and the pretax interest earned from the City of Heflin bond ($12,000)). 

How much explicit tax would she have paid on the Surething Inc. bond?

Since Melinda’s marginal tax rate is 25 percent, she would have paid $4,000 of explicit tax (i.e., 25% × $16,000) on the interest earned from the Surething, Inc. bond.

What is her after-tax rate of return on the Surething Inc. bond?
 

Her after-tax income from the Surething Inc. bond is $12,000 ($16,000 interest income - $4,000 tax).  Thus, her after-tax return from the Surething Inc. bond would be 6 percent (after-tax income of $12,000 divided by her $200,000 investment).

 

43.  [LO 3, LO 4 PLANNING] Hugh has the choice between investing in a City of Heflin bond at 6 percent or investing in a Surething Inc. bond at 9 percent.  Assuming that both bonds have the same nontax characteristics and that Hugh has a 40 percent marginal tax rate, in which bond should he invest?
    
    Hugh’s after tax rate of return on the tax-exempt City of Heflin bond is 6 percent.  The Surething bond pays taxable interest of 9 percent.  Hugh’s after tax rate of return on the Surething bond is 5.4 percent (i.e., 9% interest income – (9% × 40%) tax = 5.4%).  Hugh should invest in the City of Heflin bond. 
     
44. [LO 3, LO 4 PLANNING] Using the facts in problem 43, what interest rate does Surething Inc. need to offer to make Hugh indifferent between investing in the two bonds?

 
To be indifferent between investing in the two bonds, the Surething Inc. bond should provide Hugh the same after-tax rate of return as the City of Heflin bond (6 percent).  To solve for the required pretax rate of return we can use the following formula:  After-tax return = Pretax return × (1 – Marginal Tax Rate).

Surething Inc. needs to offer a 10 percent interest rate to generate a 6 percent after-tax return and make Hugh indifferent between investing in the two bonds – i.e.,

6% = Pretax return × (1 – 40%);
Pretax return = 6% / (1 – 40%) = 10%
 

45. [LO 3, LO 4 PLANNING] Fergie has the choice between investing in a State of New York bond at 5 percent and a Surething Inc. bond at 8 percent.  Assuming that both bonds have the same nontax characteristics and that Fergie has a 30 percent marginal tax rate, in which bond should she invest?
    
    Fergie’s after tax rate of return on the tax-exempt State of New York bond is 5 percent.  The Surething bond pays taxable interest of 8 percent.  Fergie’s after tax rate of return on the Surething bond is 5.6 percent (i.e., 8% interest income – (8% × 30%) tax = 5.6%).  Fergie should invest in the Surething bond. 
     
46. [LO 3, LO 4 PLANNING] Using the facts in Problem 45, what interest rate does the State of New York need to offer to make Fergie indifferent between investing in the two bonds?

 
To be indifferent between investing in the two bonds, the State of New York bond should provide Fergie the same after-tax rate of return as the Surething bond.  Fergie’s after tax rate of return on the Surething bond is 5.6 percent (i.e., 8% interest income – (8% × 30%) tax = 5.6%).  The state of New York needs to offer a 5.6 percent interest rate to generate a 5.6 percent after-tax return to make Fergie indifferent between investing in the two bonds. 
 

47. [LO 3] Given the following tax structure, what minimum tax would need to be assessed on Shameika to make the tax progressive with respect to average tax rates?

 
       Taxpayer     Salary          Muni-Bond Interest        Total Tax
 
Mihwah  10,000        10,000                     600
Shameika      50,000        30,000                     ???